Can S&P 1040 Hold?

by: Bret Jensen

So much for the market meandering quietly into Friday’s jobs report. Equities were crushed yesterday. All major indexes were down between 2.6% - 3.8%. Market breadth was horrid as losers led gainers by approximately 9 to 1. Volume was high as well, not comforting given volume on down days continues to swamp volume on up days.

There were three major drivers of the selloff yesterday.

  • A decline in the recently instituted Chinese Leading Indicators report triggered a 4% selloff in the Shanghai Index.
  • Worries that European banks might have trouble rolling over their debt as the ECB sought to end its one year “temporary” funding facility.
  • The June Consumer Confidence report was abysmal and came in much lower than expected.

On the bright side, the support level of 1040 was briefly breached on the S&P but continued to hold by the close… barely. A positive ADP reading on private sector jobs today and a monthly jobs report that at least meets expectations on Friday will be critical to see if this support can remain in place. Any disappointment and market will be heading lower. It has continued to be a stellar week for our long/short strategy. The long positions we have highlighted over the previous month (JNJ, VOD, PFE, AEP, etc..) continue to outperform the market albeit losing some ground. This has been more than compensated by the short positions we have recently highlighted (BID, LULU, CRM, BIDU) that have been absolutely crushed in the last few days. BIDU alone was down over 9 percent yesterday. In this type of environment it pays to stay defensive. Stick to those equities with pristine balance sheets, rock solid business models, reasonable valuations, and decent dividend yields. The next selection we would like to highlight is AT&T (NYSE:T)

Overview: AT&T Inc. provides telecommunication products and services to consumers, businesses, and other telecommunication service providers under the AT&T brand worldwide. The company’s Wireless segment offers wireless voice communications services, including local wireless communications, long-distance, and roaming services with various postpaid and prepaid service plans.

Prognosis: The stock price has been basing between the $24 to $28 for a year even though it continues to add subscribers in its wireless service and continues to roll out of its U-Verse Service. We believe the stock is ready to outperform the market over the next 12 to 18 months. We based this on the following:

Valuation: AT&T is selling for approximately 11 times this year’s consensus earnings and 10 times 2011’s projected earnings. It has a dividend yield of 6.9% and has more than enough free cash flow to support this ample dividend. It also has a single A rated balance sheet.

Catalysts: There are several factors that we believe should provide support for a higher stock price in the near and medium term:

  1. The administration seems intent to make more spectrum available for mobile communications
  2. Obviously the I-phone is a double edge sword. It is driving large subscriber gains, but is necessitating large capital expenditures to expand the network to accommodate the additional data traffic. However, it is a positive on the whole.
  3. U-Verse, which offers faster broadband and video service, is in the early stages of rollout. This is driving increased revenues per subscriber
  4. The company is doing a good job in focusing on bundling, partnering with other providers (satellite services) as well as getting long term contracts.
  5. The loss to exclusivity of the I-phone seems to be priced into the stock already

Recommendation(s): We believe the stock should be trading at a more appropriate 12-13 times next year’s projected earnings of $2.45. Given growth and ample dividend yield; our target Price is $30-$33, up from current price of $24.46.

Disclosure: Long JNJ, VOD, PFE, AEP, T, short BID, BIDU, CRM, LULU